The macro environment in India has been challenging over the last few months. Though the global funding environment has improved recently, we have been arguing that domestic factors are still holding back a V-shaped recovery. At the heart of the poor macro environment in India has been the bad mix of growth since the credit crisis unfolded in 2008.

The ratio of private investment to GDP has been declining even as consolidated national deficit remained in the range of 9-10% of GDP (excluding one-off revenues from telecom licence fees).

This divergent trend in private investment and fiscal deficit has been steadily taking down India's potential growth over the last four years. Policymakers' attempt to push for higher growth with this bad mix has brought about the vicious loop of higher inflation, current account deficit and tighter interbank liquidity. We think improvement in this growth mix is essential for the return of high growth with low inflation, the type of environment last seen in 2004-07.

Hence, we have been looking for policymakers to undertake efforts to aggressively reduce unproductive government spending and subsidies and simultaneously work towards boosting private investment. However, towards this end, Budget 2012 did not implement any meaningful measures to improve the bad growth mix.

First, on the public finances trend, although we expect the central government to be able to cut the fiscal deficit by about 0.6% of GDP in FY2013, the bulk of this reduction is due to a rise in tax burden with a hike in indirect tax rates. In our view, tax increases in the current environment of weak private investment should have been ideally avoided. Indeed, in last year's Budget speech, the finance minister commented that the government refrained from increasing tax rates because policymakers "would like to see improved business margins translated into higher investment rates".

We expect the central government's fiscal deficit for FY2013 to remain high at 5.6%, compared with the Budget estimate of 5.1% of GDP. On the expenditure side, we believe the subsidy burden, particularly for oil, is likely to be higher than budgeted. Similarly, on the revenue side, we expect tax revenues to be slightly lower than budgeted as: (a) our GDP growth estimates are lower than that assumed in the Budget, and (b) non-tax revenues are likely to be lower on account of telecom auctions, etc.

In the context of public finance management, the good news in the Budget was the continued support for the implementation of the Unique Identification (Aadhaar) scheme. The government has already started implementing pilot projects for distribution of welfare spending with the use of Aadhaar platform and it plans to scale up and roll out these Aadhaar-enabled payments for various government schemes in at least 50 selected districts within the next six months. Nonetheless, it may still take a while before we see a meaningful reduction in the non-merit subsidy burden.

The second macro issue we have been watching is the government's effort to revive private investment gradually to boost sustainable GDP growth. However, we think there are no concrete measures to boost private investment in the latest Budget. Indeed, we estimate that private corporate investment, which is the most productive component of overall investment, will remain weak at 11% of GDP in FY2013, compared to 11.7% of GDP in FY2012 and the peak of 17.3% of GDP in FY2008.

Against this macro backdrop, we believe the government's GDP growth estimate for FY2013 could be slightly optimistic. The Budget has assumed a recovery in GDP growth, from 6.9% in FY2012 to 7.6% in FY2013. Morgan Stanley's estimate for FY2013 GDP growth, on the other hand, stands at a lower 7%. Indeed, we believe that growth remaining weaker for longer than 3-4 quarters is a key risk. Considering the weak export outlook, a revival in growth would need to come from domestic demand, either consumption or investment. In the case of India, a revival in investment, more so than consumption, would be key.